The recent bad publicity surrounding German chemical firms such as Bayer, Degussa and Schering because of their role during the Nazi era is just one of the problems facing the sector at the moment.
In the words of one analyst, the outlook for the industry is "pretty appalling" and under weight is a word frequently used by analysts in connection with chemical stocks.
"Going into 1999, global economic activity is expected to decline further, resulting in a further slowdown in chemicals demand and lower chemical prices," says Mr Themis Themistocleous, analyst at Warburg Dillon Read in London. "This should be especially pronounced in Europe where demand, prices and profitability of the sector have been considerably higher than the rest of the world," he said in a recent review of the sector.
This pessimistic view is not just confined to the financial markets, with the industry bracing itself for tough times ahead. Last month, the British Chemical Industries Association (CIA) predicted that Europe's $430 billion (€392 billion) chemical industry would slow down this year under pressure from rising imports and threatened by macroeconomic factors, especially the financial crises in Asia, Russia and Latin America.
Meanwhile, the Verband der Chemischen Industrie (VCI), the German chemical industry association, cut its growth forecasts for 1999 for the second time in January after a disastrous fourth quarter performance. It is now forecasting production growth of about 1 per cent compared with an original prediction of 2 per cent. Of particular concern to European chemicals producers is the downward pressure on prices being exerted by cheap Asian imports.
The chemicals industry is wide ranging, stretching from basic petrochemicals and plastics at one end through industrial chemicals to life sciences or pharmaceuticals and agro-chemicals. In addition to the Big Three German firms - BASF, Bayer and Hoechst - the European sector includes large players such as France's Rhone-Poulenc, the Dutch firm Akzo Nobel, speciality chemical companies such as Ciba and Clariant, commodity players such as Solvay, industrial gas companies including Air Liquide and pharmaceutical firms such as Roche.
Although basic commodities such as plastics and fibres are vulnerable to competition from Asian economies trying to export their way out of trouble, the problems facing the higher value added products are more complex.
"The chemical industry itself doesn't face a great competitive threat in Europe from Asian competitors," says Mr Peter Mackey, chemicals analyst at Dresdner Kleinwort Benson in London. "It's not direct competition but the customer effect. If you are a European producer and your customer is a US fridge manufacturer and he is under competitive pressure from a fridge manufacturer in Korea, his volumes are down, he will put pressure on suppliers and this has an effect all the way up the supply chain."
The poor growth outlook for the global economy, added to the Asian issue, has overshadowed other developments in the sector, including the recent trend towards consolidation. Among those to have announced linkups in recent times are Germany's Hoechst which plans to join with France's Rhone-Poulenc to found a new life sciences joint venture called Aventis and Degussa which merged with chemicals firm Huels, a unit of Veba.
The recent spate of mergers in the sector should be good news for the industry over the long term, but given the difficult outlook, it is unlikely to provide a significant boost to earnings in the short term, analysts say.
"When economies turn down, this far outweighs any tinkering around that can be done over the short term," says Dresdner's Mr Mackey, who is forecasting a 6 per cent decline in earnings in aggregate in 1999.
He says that although there may be trading opportunities in the sector, Dresdner is likely to maintain an underweight stance for several more quarters.
"The sector is notorious for drifting sideways at a lower-than-expected trough for longer than expected," he says.
According to Warburg Dillon Read, the biggest earnings risk lies with shares perceived to be less cyclical such as Bayer, Hoechst and Akzo Nobel, where the market is still expecting a reasonable earnings performance.
For those determined to have an exposure to the sector, analysts point to stocks such as Air Liquide, the French industrial gas company, which remains relatively immune from the cyclical nature of the chemical sector generally.
Dresdner also remains positive about BASF which it believes should turn in the best performance of the "Big Three" German chemical groups, although the company is vulnerable to proposed tax changes in Germany.
Investors put off by the gloom surrounding the chemical industry might be better advised to look at pharmaceutical stocks which remain the one bright spot in the sector. They are expected to lead growth in the industry, establishing a premium of 2 per cent over the industry trend, according to Britain's CIA. Mr Ian Smith, pharmaceuticals analyst with Lehman Brothers, is forecasting pharmaceutical sales growth of around 5 per cent in Europe this year and says the sector should be able to deliver a superior growth rate over the long-term. "The benefits of new enabling technology suggest the industry can bring more drugs to the market than ever before and that is a long-term positive," he says.
Investors should be aware that this has already been factored into many stocks which are trading on high multiples which allow for their future growth rate. However, analysts believe the major companies such as Roche are well positioned to do well going forward.
The sector has felt the effects of consolidation in recent times, a trend analysts believe is set to continue.
Zeneca has announced plans to merge with Sweden's Astra to become the world's third biggest prescription drugs company, a move approved by the European Commission earlier this week, while Sanofi, a subsidiary of Elf Aquitaine, and Synthelabo, part of cosmetics group L'Oreal, also plan to merge in May.
